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This Is Why Buffett's Buying Stocks

You think you've had a bad year? Poor Warren Buffett has seen more than $16 billion evaporate from his net worth as Berkshire Hathaway (NYSE: BRK-B) followed the market's swoon.

Adding insult to injury, he's been criticized for the awful performance of recent investments in Goldman Sachs (NYSE: GS) and General Electric (NYSE: GE) . In addition to preferred shares that pay 10% dividends, he got warrants for common shares at what seemed like great prices -- prices that are more than 50% higher than the stocks are currently trading.

In response to the market panic, Buffett recently penned an op-ed in TheNew York Times saying he was buying U.S. stocks for his personal portfolio. Since then, markets have been drowning in a sea of red ink.

Has the Oracle of Omaha lost his touch?

Seriously?Simon Maierhofer thinks so. In fact, he took issue with Buffett's claim that stocks will outperform cash in the coming years:

How did [Buffett's] "cash is trash" philosophy fare over the past 10 years? $10,000 invested in the S&P 500 exactly 10 years ago would be worth $7,500 today. The safest cash equivalent, [Treasury bills] ... would have returned about 30%, putting you at $13,000. We don't encourage investing by looking in the rear view mirror but a look at the numbers shows that the only bull market right now is in cash.

Let's leave aside for a moment the question of inflation, which ensures that the $10,000 of 10 years ago is not, in fact, the equivalent of $10,000 today. What does the market's performance over the past 10 years suggest for the future?

Up, up, and awayAny 10-year retrospective has to contend with the fact that 1998 was smack in the middle of the dot-com boom, when tech companies like Microsoft (Nasdaq: MSFT) and Yahoo! (Nasdaq: YHOO) and even stalwarts like Coca-Cola (NYSE: KO) and Procter & Gamble (NYSE: PG) traded like infinite growth was engraved in the stock price. Since then we've seen not one, but two bubbles burst. The fact that trailing 10-year returns are pretty bad is hardly news.

But if we look at 10-year returns for the Dow Jones Industrial Average over the past 100 years, a pattern emerges:

10-YearPeriod

Dow Jones IndustrialAverage Return

1998-2008

(9%)

1988-1998

331%

1978-1988

165%

1968-1978

(19%)

1958-1968

77%

1948-1958

226%

1938-1948

14%

1928-1938

(49%)

1918-1928

254%

1908-1918

60%

After booms come busts, after busts come booms. That's how markets work. If we had chosen a different frame (i.e., ending in 2006 instead of 2008), the numbers would likely be different, but the overall pattern would be the same.

This isn't a short-term, cherry-picked set of data, after all. It's 100 years of market returns, during which time the nation overcame two world wars, four smaller wars, a flu epidemic, the Great Depression, civil uprisings, multiple recessions, oil shocks, and terrorist attacks -- not to mention sideburns, Chia Pets, Carrot Top, and boy bands.

Anything can happen in the short term -- and the short term right now is volatile and unpredictable, as it always is. Over the long term -- going back an entire century -- the trend of the stock market is pretty clear.

But the author doesn't just claim that the past 10 years have been rough for investors -- he claims that this proves investors should be in cash going forward. The problem is, that 30% return he cites in T-bills doesn't account for the 27% compound inflation over the past 10 years, which leaves cash roughly holding even -- and that's largely true across time periods. And if you hold cash as actual cash, well, inflation just keeps taking its bites out, leaving you with less than you started with.

It's time to be braveYes, stocks are volatile, especially now. Yes, there will be boom times and bust times -- and the busts are no fun, even when we're resigned to their presence. But if you want your money to earn you positive post-inflation returns over the long term, cash isn't going to get you there.

None of this is to say we've reached a market bottom just yet. Historical earnings multiples, for example, suggest that more pain could be in store for investors, and some periods of market lethargy have indeed lasted for longer than 10 years.

Nonetheless, the trend is as true today as it's been for the past century: We're at a point where bargain-hunting investors can be as assured as they've been in decades that stocks will perform well in the long term.

Our team at Motley Fool Inside Value is sifting through the rubble in search of the bargains that will translate into long-term opportunities. To see what they're recommending right now, click here to try the service free for 30 days. There's no obligation to subscribe.

Comments from our Foolish Readers

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I just ran the numbers on that chart and a $10K investment in 1908 translates to just shy of $1.6M today. I'm with Warren on this one. Steady, long term investing always beats the short sighted cynic.

I bought several shares of Citigroup (NYSE: C) back in July when it was over $16 per. It closed below $4 today and federal bailout terms indicate that I won't be seeing that juicy yield I was looking at for another 3 years. Am I disappointed? Yes. However, I'm investing for the long term so I'm nowhere near panic mode.

Buffett didn't have a cash is trash philosophy 10 years ago. As a matter of fact, he stated that he thought investors would be disappointed with returns on stocks over the next decade. How'd he do with that call?

Today, with valuations much more attractive than they were a decade ago, he feels that stocks will offer much more attractive returns than cash over the next 10 years. I have a feeling he might be right, again.

Buffett EXPLICITLY stated in this op-ed piece not to buy over-leveraged entities. What are you doing in C, the monster with 3 trillion assets (at least 1 trillion bad ones) and less than 100 billion shareholder equity?

What Buffet is really saying (and has always said) is that it takes a very smart fool to predict the short term direction of prices and most people should not bother.

But any fool with the most basic understanding of valuation and a slide rule can spot a company that is cheap. And today their are companies that will be very much around in 10 years time (at least 19 out of 20 will) that are trading in some cases below book and in other case delivering an earnings yield higher than a junk bond (yes earnings will come down, but the point is to look at free cash flow over the whole business cycle to get an adjusted fcf or earnings yield.)

Forget trying to guess where the market is going tomorrow and take a bottoms up approach. Buffet did not become a billionaire by being a rocket scientist.

DBrown7, you read my mind. Buffett said that cash is trash right now - he wasn't saying that 10 years ago. He stated in the op-ed piece that he was in US govt bonds (if they were relatively short-term, this is essentially cash) up until recently, and that now he's buying US equities.

Should I trust the opinion of Warren Buffett or Simon Maierhofer? Not much thinking required to answer that question!

While I agree generally with the concept that this is the time to buy stocks. The theory posted by GeekXInfinity that 10grand then is 1.6M now is preposterous.

Many of the stocks in the Dow in 1908 don't even exist today. I'd like to know what you'd have if your grand father bought that particular basket of stocks then, held them and passed them to you. I'll bet it doesn't crack a hundred grand. Factor in tax on the dividends, and inflation.

That 10G in 1908 would buy a pretty nice pad. The basket of stocks today wouldn't cover a down payment on the very same place now. Don't get me wrong. Realestate has been my second worst investment decision.

I've lived my life below my means, saving and investing the rest, I carry no debt. What's it got me? I'm down 40% in my net worth since 2006. The only investment that pays long term seems to be fraud. It works for the gov, it works for the banks and it works for the crooks. My best friend from highschool can't keep a job, goes bankrupt at least once a decade and lives like a prince on credit. I think he had the right combo all along. The recent economic problems haven't cost him a dime!

notice the absolute worst you could have done, and you would have had to been invested in the market as a whole, was 49% .... a little prudence would certainly have reduced that amount, but even then, just sitting would have increased that to at least 200% by now